The recent set of amendments effected by the Securities and Exchange Board of India to the SEBI (Disclosure and Investor Protection) Guidelines, 2000 (“DIP Guidelines”) in terms of a circular dated August 28, 2008 (“SEBI Circular”) contains an unexpected surprise.
The SEBI Circular 2(vi) states:-
“Presently, as per the guidelines on preferential allotment, warrants issued on preferential basis are subject to lock-in for a period of one year or three years, as the case may be and lock-in on shares allotted on exercise of such warrants is reduced to the extent such warrants have already been locked-in. It has been decided to subject the shares so allotted pursuant to exercise of warrants to full lock-in period of one year or three years, as the case may be, from the date of allotment of such shares.”
Currently, any convertible instrument issued on a preferential allotment basis (out of turn allotment to specifically identified persons pursuant to Section 81(1A) of the Companies Act, 1956) by a listed company would be locked in (“locked up” in the parlance of other jurisdictions) for specific periods. Preferential allotment to promoters (persons in control of the listed company) are locked in for three years (not exceeding 20% of the company’s capital) while preferential allotment to other persons would suffer a lock-in of one year.
When a warrant is issued, the warrant itself would be locked in for the specified period. Should the warrants get converted into shares during the lock-in period, the residual period of lock-in would fasten onto the resultant shares.
The SEBI Circular could be interpreted in two ways:-
a) that the lock-in would apply to the warrants, and again to the shares arising out of conversion of the warrants; or
(evident from a plain reading)
b) that the lock-in would apply only to the shares arising from conversion of the warrants, and not to the warrants allotted.
(not evident from a plain reading – but arguable in trying to ascertain legislative intent)
However, the amendments to Clause 13.3.1 of the DIP Guidelines (the charging provision prescribing the lock-in) give the ambiguity a new dimension. The substantial charging provisions that impose a lock-in on instruments allotted on a preferential allotment basis (including shares, warrants and other convertibles) have been left undisturbed. Clause 13.3.1(d), which deals with the set-off for lock-in already suffered by a convertible instrument, has been amended, purportedly to give effect to the intention set out in the SEBI Circular.
Clause 13.3.1(d) earlier read as follows:-
"The lock-in on shares acquired by conversion of the convertible instrument / exercise of warrants, shall be reduced to the extent the convertible instrument warrants have already been locked-in."
(extracted verbatim without correcting syntax)
The amendment effective August 28, 2008 (and applicable to all allotments for which notices to shareholders are sent out after August 28, 2008) results in Clause 13.3.1(d) reading as follows:-
“The lock-in on shares acquired by conversion of the convertible instrument shall be reduced to the extent the convertible instrument have already been locked-in.”
(extracted verbatim without correcting syntax)
A plain reading of the amended clause would show the removal of reference to the term “warrants” was a removal of redundant terms – since warrants are, in any event, convertible instruments, and as such do not need to be specified separately. In other words, the legal effect of the amendment is not that the shares arising out of conversion of warrants would to enjoy a set-off for the lock-in already suffered by the warrants. It is only the covering language in the SEBI Circular that suggests that the intent of the amendment was contrary to the effect of the amendment.
Either of the approaches to interpreting the SEBI Circular leads to absurd consequences:-
a) Locking in the warrants first, and then, separately, the shares arising upon conversion would to a strange situation. The maximum timeframe permitted in the DIP Guidelines for conversion of warrants is 18 months. Therefore, one could have a situation where a warrant is already out of the lock-in period of 12 months and then gets converted into shares – say, in the eighteenth month since its issue. The warrant could have already been transferred between the twelfth month and the eighteenth month. However, the shareholder who freely acquires the warrant and exercises it to convert the instrument into shares before it lapses would suffer a new lock-in on the shares allotted to him. There can be no logical legislative reasoning to back such a framework.
b) Locking in the shares arising upon conversion alone, and not the warrants would also be illogical. There can be no reason for the warrants preferentially allotted to be freely transferable and yet, imposing a lock-in on the shares arising upon exercise of the warrants.
There is yet another legislative incongruity here. It is evident that the period of lock-in suffered by an optionally convertible debenture would be set off against the lock-in to be suffered by shares arising from conversion of such debenture. However, there can be no logical argument to disentitle shares arising out of conversion of warrants from a similar treatment. In the absence of any stated reason for the regulator picking a particular form of convertible instrument for differential treatment, one could only ponder over why warrants are being killed as an instrument in the Indian securities market.